ETF Rebalancing: Keep Your Allocations In Alignment

I spent 6 weeks in the first quarter of 2006 rebalancing my investment allocations so that my holdings would be inline with my targets. The idea of rebalancing once or twice a year is now a generally accepted tactic among many investment professionals and it seems to make sense to me. Also, from what I've seen, even 401K plans allow contributors to easily rebalance their portfolio adding more legitimacy to the practice.

Rebalancing is a variation on the buy low, sell high theme. When you rebalance, you are, in effect, putting more money in to assets that have performed, in relative terms, worse than other assets. And at the same time, you may be selling off some assets that have performed well relative to other assets. As a buy-and-hold kind of investor, I don't sell any assets to rebalance. Instead, I just buy more of whatever is below my targets. As an added benefit of rebalancing this way, I don't trigger any capital gains because I don't sell anything.

As you might imagine, ETFs make it simple to rebalance a portfolio because of their clear asset classification and the ease in which they can be bought and sold. I also like to use a little dollar cost averaging just to make sure I don't catch a sudden dip in the market right after a large purchase.